Dispatches

Pension Reform Plan: Taxpayer Costs Must be Fixed, not Unlimited

“If 50 people say you’re drunk you probably ought to lie down.”  – Jim Rockford, Rockford Files

The discussions going on in Springfield regarding pension reform still have not addressed the key concern: taxpayers must have a reasonable, fixed annual cost going forward. They cannot be on the hook for everything that can and will go wrong between now and 2062. Any increased pension costs beyond the agreed, affordable fixed taxpayer portion must either be paid for by other employees or result in automatic pension decreases.

Pension costs must be part of total compensation, not separate and apart.

The biggest single problem that needs to be addressed as part of any comprehensive pension reform in Illinois is the idea that taxpayers are responsible for every shortcoming of the current system whether it is investment returns,benefit increases or 8.5% interest charges on assets that do not exist. Currently this is accomplished by having the state pay pensions separate from the operating budgets of each government unit. Thus one party determines salaries, fringe benefits, vacations, sick leave etc. and the pensions are paid by the state regardless of the cost.

What needs to be done is to fix the taxpayer portion of the cost and assign all pension costs above that amount to the operating budgets of each government unit whether State Police, community colleges or K12 school districts. Total compensation paid to each public employee should include the costs of pensions and when that is not the case salaries automatically rise to fill the gap left by pension cost not being part of total compensation. This is exactly what happens in Illinois now because those who determine salaries and fringe benefits are not assigned pension cost responsibility. This results in Illinois taxpayers paying more both for salaries and pensions.

This pension proposal assigns pension costs to operating entities and shows how to pay for them. It fixes taxpayer pension cost at 15% of payroll and all pension cost in excess of that must come out of departmental budgets and employee compensation costs.

The goals of this pension reform proposal are as follows:

  1. Fix taxpayer pension costs at a reasonable figure similar to what would be paid in a Social Security/401K plan.
  2. Force managers to manage by assigning all compensation and health care costs to their budgets. Freeze those budgets for 5 years.
  3. Make employees understand that there are only so many dollars available and that pension contributions are part of their pay and if pensions go up then salary or fringe benefits must come down. A compensation dollar can only go towards one compensation element.
  4. Give employees some flexibility by allowing them to switch compensation elements around as long as the total does not exceed their assigned total compensation value. More insurance and less pension or less insurance and more salary for example.
  5. Give employees more cash-out options than they have now as long as it does not increase pension costs. This can be done by adjusting pension payouts down slightly and will make pensions more portable similar to 401K’s.
  6. Attempt to get reform buy-in from all groups by emphasizing the draconian cuts (including employment itself) that will and must be made if taxpayer pension costs are not reduced substantially.
  7. Quick resolution is mandatory and a legal resolution will take years to resolve. Amending the constitution will also take years unless we can round up 300,000 signatures.

We need to get Illinois Open for Business by solving the problem quickly and efficiently. As it stands now no business in their right mind would open shop here and many are leaving. We must be competitive or we will wither and die on the vine. We can either be the next Indiana or the next Michigan.

The bomb is ticking and time is running out.

STATE OF ILLINOIS PENSION REFORM PLAN

 

PART 1: PURPOSE, REASONING AND IMPLEMENTATION.

A. PURPOSE:

 To limit taxpayer liability to 15% of state employee payroll.

 B. REASONING:

 As the pension law is currently constituted, taxpayers are required to pay all shortages in the pensions’ short and long-term liabilities plus interest at 8.5%. Employees’ liability is limited to their current contribution rates (4% to 8%). Thus whatever the unfunded pension liability is ($85, $150, $200 billion?) 100% of it must be paid for by the taxpayers via higher and higher taxes.

 (Argument for: why do the 95% of Illinois workers who do not belong to the state pension system have to contribute via taxes 4 times as much as the than the 5% who do?)

 C. JUSTIFICATION:

 The very best private sector pension system costs about 14% of employee payroll – 6.2% for Social Security and 8% matching 401K contributions. Therefore this bill, at 15% of payroll, would provide the highest paid employer pension/retirement contribution in Illinois.

 (Argument for: What could be fairer than the highest contribution in the state?)

 D. IMPLEMENTATION:

 Step 1: Define “Total compensation” for every job description as consisting of the following elements for budget purposes:

  1. Salary
  2. Plus overtime cost
  3. Plus pension contribution cost (local, state, federal)
  4. Plus health insurance cost
  5. Plus other insurance (life, disability, dental, vision) cost
  6. Plus sick days accrual cost
  7. Plus personal days cost
  8. Plus vacation days cost
  9. Plus holiday days cost
  10. Plus education reimbursement cost.

 (Argument for: every one of these costs is paid for by the taxpayer therefore the taxpayer must control each of them as part of the total employee cost.)

Step 2: For state and university employees freeze that compensation cost at 2010 levels thru 2015 at which time it will be reviewed. For K-12 employees see below.

 (Argument for: they probably should be cut not frozen.)

Step 3: State and university departmental budgets are frozen at 2010 level plus pension contribution (equal to 15% of payroll) and health care costs from state. Then from this point forward the managers of each state/university department/unit-of-government are now responsible for allocating costs for all 10 elements of “Total Compensation” as listed above. Thus pension costs over 15% of payroll would have to come out of the rest of the budget see “Allowable Pension Budget Adjustments” below.

 The state would no longer accept responsibility for funding pension and health-care costs on an unlimited, ad-hoc basis. Costs would be allocated to the departments that generate and control those costs by their hiring and promotion policies. It is up to the managers who are being paid to manage to control and allocate costs just like in the private sector. No more “we don’t care because the state picks up the cost”. Their pay will depend upon how well they manage their costs as well as the execution of their business plan. For health insurance multiple lower-cost options would be provided including HSA’s.

 (Argument for: it’s time to make managers manage.)

Step 4: Schools K12 are independent units with independent sources of elected control and revenue sources therefore it is only proper that they too be responsible for controlling all of their costs including pensions. Therefore pension cost equal to 15% of payroll would be paid by the state but all amounts in excess of 15% would be allocated back to the schools based upon average certified full-time salary. Thus schools that paid the highest salaries would be allocated the highest portion of excess pensions to pay, formula to be determined. Salary increases in excess of 5% or the average of other workers in the pension system (whichever is lower), as determined by state actuaries, would also be the responsibility of the local district with that portion in excess being allocated to school districts under the average thus lowering pension costs for schools who control salaries. In addition if non-classroom costs are above a certain level (50%) then districts would be liable for all pension costs. Alternatively, state funds could be withheld from high pension cost districts in lieu of pension payments.

(Argument for: those that create the pension problem with excessive salaries should pay for the pensions.)

PART 2: HOW PENSION COSTS CAN BE ALLOCATED.

A. ALLOWABLE PENSION BUDGET ADJUSTMENTS:

State and University:  Once a “Total Compensation” value is arrived at adjustments could be made by the managers annually to fit their budget needs.

 Currently state pension costs are about 33.3% of payroll (including interest on pension bonds) and change every year according to multiple assumptions used by state actuaries. Health care costs are about 20% of payroll.

As an example let’s use a department with a $10 million budget in 2010 with a $6 million payroll. The budget for 2012 would be $12.1 million because the state would kick in $900,000 (15% of payroll) for the state’s share of pensions. It would also provide the health insurance cost of $1.2 million (20% of payroll). That leaves 18% of payroll or $1.1 million for the department’s share of pension costs that the department must come up with out of its budget of $12.1 million. In effect the manager must squeeze 9% out of his budget to pay for pensions.

Here are some cuts that can go towards the 9% (all %’s approximate):

  1. One day a month furlough – 2%
  2. Health Savings Accounts instead of the state insurance plan – 4%
  3. Change maximum vacation days to 3 weeks from 5 weeks – 1%
  4. Sick day accrual 10 days to 5 days – 1%
  5. Layoff 4% of employees – 3%
  6. Lower final pension by 5% – 2%
  7. Allow employees with needed skill sets to work as sub-contractors at a rate lower than their total compensation. College faculty and administrators would excellent recruits for this type of privatization. They would then be responsible for their own pensions and fringe benefits. See “If It’s in the Yellow Pages Privatize It” below. Savings variable.

As mentioned before K-12 are independent of the state and must determine their own cuts but all of the above apply to them also.

Note that in the above example if employees agreed to take 8% less in pensions no layoffs would need to be made. Since the current pensions are 3 to 10 times better than Social Security this might be an agreement all employees could agree on. In fact state employees, who have Social Security and the best dollar for dollar pension plan in the state, could cut their pensions and still retire with take home pay greater or equal to their final working take home.

(Argument for: One, state employees have a pension system far superior to anything in the private sector and therefore they should pay more for it; secondly taxpayers MUST have a limited liability.)

B. CHANGE IN PENSION RULES THAT COULD LESSEN CUTS:

  1. Increase employee pension contributions by 4% (2% for those on Social Security). This would be the equivalent of lowering the pension Interest Rate of Return to 6% from 8%; which is more realistic (recalculate the Normal Cost.)
  2. Eliminate all “Spiking” by restricting final year’s salary increase (auto 6%/yr. increase for 4 years for teachers for example). Salary increases limited to cost of living last 4 years and only base salary can be used for pension calculations.
  3. Use last 8 years salaries for average not last four or last one as in the case of legislators and Illinois State Police.
  4. Reverse all benefit enhancements since 1998 including Early Retirement Option for teachers and sick leave accrual used for pension credit.
  5. Tax state pensions over $50,000 and earmark money for pension payments.
  6. Revert COLA to 1970 pension rules: 1.5% not compounded and earmark money for pension payments.
  7. Pay off pension bonds thus eliminating interest costs.

(Argument for: this eliminates many “gimmicks” that have been added just to enhance what was already an outstanding pension plan. These are items that are especially irksome to taxpayers.)

C. EMPLOYEE REFORM ENHANCEMENTS:

  1. Sell State Assets and use the money to pay off pension bonds. Anything left would be added to pension assets.
    • Tollway
    • Lotto
    • Real estate including but not limited to: buildings, Thompson Correctional, parks
    • Oil/ gas leasing rights to the New Albany shale gas fields covering most of Eastern IL.
  2. Allow employees at anytime to take their contributions with interest actually earned plus state’s 15% contribution without interest and leave the system. Actuarial adjustment to pensions would be required for this option to be implemented.
  3. Allow employees to adjust their compensation according to their needs as long as the total cost remains the same. For example they could reduce pension and increase insurance coverage or cut vacations and increase salary

 

(Argument for: providing enhancements for employees would help sell the plan. If the cost to the state is neutral why not do it? The goal is to reduce state pension costs to manageable levels, end economic uncertainty and avoid long, drawn out legal action.)

PART 3: WHAT HAPPENS IF AGREEMENT IS NOT REACHED?

A. IF IT IS IN THE YELLOW PAGES PRIVATIZE IT:

This was former FL Gov. Jeb Bush’s rule on reducing state costs and influence. All we would need to do this is hire one of his former assistants to head up the program in IL. Some functions that come quickly to mind are janitorial services, trucking, IT services, phone banks, corrections, Tollways, Lotto etc. Illinois State Police functions could be outsourced to county sheriff’s departments if the sub contract cost is lower. Education credits for home schooling and private schools are another area ripe for savings in direct payroll as well as pensions and fringe benefits. Make teachers of non-academic subjects (Drivers Ed, Music, Art etc.) and non-tenured college faculty sub-contractors rather than employees. Sub-contracting is already done at the community college level why not at K-12 and at 4-year institutions?

(Argument for: the ultimate solution to high pension costs is to eliminate employees. Once an employee is fired or sub-contracted your pension costs go to zero.)

B. COST SAVING OPTIONS IF AGREEMENT NOT REACHED:

The following items are NOT guaranteed by the Constitution and therefore can be “diminished and impaired” at will.

  1. Salary cuts, furloughs and layoffs.
  2. Health insurance contribution increased substantially including retirees.
  3. Vacations cut.
  4. Sick days and retirement accruals eliminated completely.
  5. Holidays cut from 12 to 8.
  6. Life insurance eliminated.
  7. Outsourcing begins including Drivers Ed back to private sector.
  8. 100% of pension costs transferred to local school districts.
  9. Tenure law opened for revision including elimination or severe limits.
  10. Collective bargaining law reopened for revision.
  11. Open Meetings Act expanded to include public participation in all labor contracts.
  12. New law requiring voter approval of all contracts increasing costs more than the Cost-of Living.
  13. End of career (last 5 years) raises limited to cost-of-living.
  14. Option to pay all pension amounts over $75,000/yr. with state IOU’s.
  15. Education funding frozen or cut.
  16. Allow Community Colleges to offer 4-year degrees thus lowering state costs by cutting enrollment at high cost state universities.
  17. Initiate change arbitrarily and let the courts decide if it’s legal (see LEGAL OPTIONS BELOW).
  18. Begin Constitutional Amendment process (300,000 signatures or 60% vote in House and Senate).

 (Argument for: if pension costs cannot be limited then they must come out of current budgeted items. Legal changes must be made to minimize liability.)

C. REVIEW OF LEGAL OPTIONS:

Legal opinions are varied. The Chicago law firm Sidley Austin has studied the issue and are convinced in-place changes to pension rules (higher contribution rates, later retirements, etc.) can be made without abrogating the Constitutional guarantee. Their reading of the law says that employee’s pension accruals are guaranteed but only up to the day changes are implemented. From that point forward, the new rules apply.

 

On the other hand Professor Amy Monahan of the University of Minnesota Law School says no, whatever the rules were in place when they were hired are guaranteed until they retire. Therefore interim changes cannot be made.

 

They both agree that a Constitutional Amendment can make serious changes including eliminating the guarantee and imposing draconian limits including reverting to the previous legal framework called “gratuity pensions” which were not and are not guaranteed at all. Texas and Indiana have “gratuity” pension systems. Social Security is a “gratuity” system so why shouldn’t they all be “gratuity”?

 

There is also the question of changes being made against the constitutional contract guarantee if it is “to serve an important public purpose” or if the original contractual obligation “had effects that were unforeseen and unintended by the legislature”. One would think state de facto or de jure bankruptcy was “unforeseen and unintended.”

 

CONCLUSION:

 

The electorate is angry and much more knowledgeable of pension abuses now than they were just a few years ago. A constitutional amendment should be put forward sometime between now and 2015 if a reasonable limit is not established soon for taxpayer pension liabilities. We need a plan similar to this, severely limiting taxpayer liability going forward or a serious conflict will arise and it will be ugly and drawn out.

 

If in 1970 politicians had told us that at some time in the future pension tax payments would reach 82% of state employees pay would we have voted for the constitutional amendment?  Of course not.And that 82% is what we are currently paying for – hold on – the politicians pensions in the General Assembly Retirement System.

 

Ironic?  No, infuriating.

 

Just because something is legal does not mean it is not corrupt. The state pension system is corrupt and needs to be changed. If it isn’t Illinois will see an exodus unlike anything it has seen before. And it won’t be the poor people leaving either. It will be the taxpaying public.

 

At that point, the only way to pay Illinois bills will be to tax moving vans.

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